Financial Markets, Monetary Policy, Fiscal Policy, Supply-Side Policies, & Globalisation Flashcards
what is the foreign exchange market ?
commonly known as forex, FX, or currency market.
a market where currencies are traded, mainly by international banks. determines the relative value of different currencies.
what is debt ?
what a firm owes
what is equity ?
all physical and financial assets owned by a firm
what is the formula for yield ?
(annual coupon payment/ current market price) x 100
what are commercial banks ?
financial institutions that make profits by selling banking services to their customers.
they manage deposits, cheques, and savings accounts for individuals and firms.
they make credit using money saved with them.
what are investment banks ?
assist in raising finance for companies, financial institutions, governments, and organisations.
they facilitate the trade of stocks, bonds and other forms of investment
what services do commercial banks offer ?
- loans to individuals, consumers and businesses e.g. mortgages
some loans are secured against an asset, to protect the banks fund if the loan is not repaid. - provide safekeeping and returns for savings
demand and fixed deposits - overdraft
- investment funds (bonds treasury bills)
what services do investment banks offer ?
- they issue shares and bonds
- provide advisory services for companies undergoing mergers or acquisitions
what is liquidity ?
the ease in which assets can be turned into cash
what is the central bank (Bank of England, in the UK) ?
the government’s bank that issues currency and controls the supply of money in the economy.
what are the 4 main roles of the central bank ?
. lender of last resort
. the governments bank
. regulate the banking industry
. monetary policy
what is the lender of last resort ?
Commercial banks are able to borrow from the Central Bank (Bank Of England) if they run into liquidity issues.
Without this help, they might go bankrupt, leading to instability in the financial system and a potential loss of savings for many households.
prevents a ‘run on the bank’, which is when consumers withdraw their bank deposits in a panic, because they believe the bank will fail.
what does it mean by the central bank, regulating the banking industry ?
due to a high level of asymmetric information in financial markets, it requires that commercial banks be regulated in order to protect consumers
what is the monetary policy ?
the Central Bank taking action to control the money flow of the economy by influence interest rates, the money supply, credit and the exchange rate.
what is the monetary policy used to help the government achieve ?
macroeconomic objectives
what is the monetary policy committee (MPC) ?
a committee of 9 members who meet each month to discuss what the interest rate should be. they are responsible for setting the base interest rate, in order to meet the target rate of inflation (2% CPI)
they also discuss whether quantitative easing is necessary
what is quantitative easing ?
a method used to stimulate the economy when standard monetary policy is no longer effective.
occurs when the central bank purchases corporate and government #bonds (form of a loan) from commercial banks and the government using money they have created, to increase the money supply. this should encourage more lending to firms and individuals, making the cost of borrowing lower.
in theory:
commercial banks lower lending rates → consumers and firms borrow more → consumption and investment increase → AD increases
————————————–
if inflation gets too high, the Bank Of England can reduce the supply of money in the economy by selling their assets.This should reduce the amount of spending in the economy.
what is expansionary monetary policy ?
- reducing interest rates
-increasing quantitative easing
aiming to boost economic growth
what does the components of AD, have to do with monetary policy ?
changes to monetary policy can influence any of these components - and often several of them at once.
Expansionary monetary policy aims to shift aggregate demand (AD) to the right
what are hot money flows ?
when the exchange rate appreciates/ increases - exports are more expensive and imports are cheaper, resulting in a fall in AD.
what is more predictable, monetary policy or fiscal policy ? ,why?
fiscal policy
because households may not borrow more money if their confidence in the economy is low - irrespective of how low interest rates go.
what are the 4 monetary policy actions ?
interest rates
exchange rates
money supply
forward guidance
what is the use of exchange rates ?
to reflect the value of one currency relative to
what is the bank rate ?
the interest rate set by the bank
what are the factors to be considered when setting the bank rate ?
economic expansion (increases AD)
&
economic contraction (decreases AD)
what are the two main instruments if the monetary policy ?
- adjustments to the interest rates
- quantitative easing
what are the effects of a decrease in interest rates on consumption ?
loans are cheaper → consumers borrow more → consumption increases
what are the effects of an increase in interest rates on consumption ?
loans are more expensive → consumers borrow less → consumption decreases
what are the effects of a decrease in interest rates on inflation ?
buyers borrow more → asset prices increase → households with assets feel wealthier → consumption increases → AD increases → inflation increases
what are the effects of an increase in interest rates on inflation ?
buyers borrow less → asset prices decrease → consumption decreases → AD decreases → inflation decreases
how will the the monetary policy committee lower inflation ?
increasing interest rates
historically, what has a lack of regulation of financial activities led to ?
risky loans
poor investments
banking losses
what are the reasons banks fail ?
high risk loans (lending credit to borrowers with poor credit histories, to buy largely inflated assets e.g. reason why housing crisis in 2007, and the Financial Crash in 2008)
regulation violation
(Banks can fail if they do not follow regulatory requirements or operate within the recommended guidelines)
asymmetric information
what is the fiscal policy ?
the manipulation of government spending and taxation (revenue) to influence aggregate demand in the economy
what is expansionary fiscal policy ?
aims to increase AD by:
+ reducing taxes
+ increasing government spending
+ subsidy’s for firms
can worsen the government budget deficit
what is contractionary fiscal policy ?
aims to decrease AD by:
- increasing taxes
- reducing government spending
- indirect tax on firms
improves the government budget deficit
what is the main reason fiscal policy is used ?
to help the government achieve their macroeconomic objectives
(low and stable rate of inflation, economic growth)
what are some macroeconomic impact of fiscal policy ?
*Income tax cuts can influence labour to be more productive
*Tax cuts can encourage firms to increase output or be more entrepreneurial
*Subsidies can lower costs of production in the industry, leading to higher output
what is the influence of government spending on economic activity ?
Government spending is an injection and increases economic activity
what is the influence of taxation on economic activity ?
Taxation is a withdrawal and decreases economic activity
what are automatic stabilizers ?
are automatic fiscal changes that occur as the economy moves through stages of the business/trade cycle
what are the effects of automatic stabilizers in a recession ?
there will automatically be lower tax revenue
-due to the nature of progressive taxation - as incomes fall households are taxed less
what are the effects of automatic stabilizers in a boom ?
there will automatically be higher tax revenue
-due to the nature of progressive taxation - as incomes rise, households are taxed more
what are the main sources of government revenue ?
taxation
sales of goods and services by govern met owned firms
The sale of government owned assets (Privatisation)
what are current expenditures ?
daily payments required to run the government and public sector
what are capital expenditures ?
investments in infrastructure and capital equipment
what are the main reasons for government intervention ?
support firms
correct market failure
support poorer households
correct government revenue
what are the two main uses of taxes ?
reduce the consumption of demerit goods
redistribution of income (from rich to poor)
what is a progressive tax system ?
As income rises, a larger percentage of income is paid in tax
what is a regressive tax system ?
As income rises, a smaller percentage of income is paid in tax
how is a budget deficit financed ?
through public sector borrowing
- This borrowing gets added to the national debt (the cumulative total of past government borrowing which has to be repaid with interest)
what is crowding out ?
a financial strategy to pay back national debt
When governments borrow money from the private sector, they do so by selling bonds (treasury bills) to people who want to save.
this leaves fewer funds in the private sector for firms to use, crowding them out of the market.
if the government is borrowing lots of money the interest rates might increase, discouraging spending and investment in the private sector.
why does national debt limit future growth ?
future generations will have to pay off the loans, which have a rising interest rate
what is the aim of supply side policies ?
to improve the long run productive potential of the economy, by shift the long run aggregate supply curve (LRAS) outwards.
what are the two categories of supply-side policies ?
- interventionist policies
- free market policies
what are the main goals of supply-side policies ?
- long term growth
- improving competition
- increasing labour market flexibility
- increase international competitiveness
- increasing incentives
- reduce structural unemployment through improving education and training
how can supply side policies affect macro economic objectives ?
economic growth (higher real GDP)
reduce labour costs
reduce average price levels (reducing inflation)
how do Supply-side Policies Reduce the NRU ?
education & training (higher skilled workforce reduces structural unemployment)
lowering taxes on labour, reduces barriers to employment, reducing frictional unemployment
what are the aim of market-based supply-side policies ?
to free up markets, from government intervention.
improve market incentives to increase long run aggregate supply
what are some market based policy’s ?
reducing income tax, leading to greater investment
deregulation
decreasing or abolishing the minimum wage to lower cost of production
what are the advantages of free market supply side policies ?
Improved resource allocation: (increasing the productive capacity of an economy requires more efficient use of its resources, including labour)
No burden on government budget:
(with an emphasis on freeing up markets and allowing market forces to drive efficiency and resource allocation, there is no requirement for government spending)
what are the disadvantages of free market supply side policies ?
distribution of incomes worsens
time lags
environment damage from infrastructure projects
what is the aim of interventionist supply-side policy’s ?
to require government intervention in order to increase the full employment level of output.
what are some interventionalist supply side policy’s ?
gov spending on education and training
gov spending on healthcare so that productivity improve
promote competition
subsidising the relocation of workers, to reduce geographical immobility of labour.
what are the advantages of interventionalist supply side policies ?
Improvements in living standards:
(Improvements in Infrastructure can raise the quality of life for all citizens)
what are the disadvantages of interventionalist supply side policies ?
Costs:
they are expensive to implement and are paid for using tax revenue - or increased government borrowing
Time lags:
due to their long-term nature, changes in government often result in changes to budgets and scope of projects and the end result may be less effective than it could have been
what is globalisation ?
the increasing interdependence of world economies.
involving free-trade
what are the six in consequences of globalisation ?
economies of scale
technology improvement (easier and cheaper to communicate)
increasing number of multinational corporations (attempt to take advantage of economies of scale)
deregulation
FDI
Containerisation (cheaper to ship goods across the world)
what has increased globalisation ?
improvements in technology and the speed of global connections have exponentially increased the level of interdependence nations
what are some consequences of globalisation for less-economically developed countries ?
employment opportunities
depletion of natural resources
increased power of monopolies
what are some consequences of globalisation for more-economically developed countries ?
increased trade
increased captial
what is a multi-national corporation (MNC) ?
a company that has business operations in at least one country other than its home country
what are the 4 characteristics and functions of money ?
- medium of exchange
- measure of value
- store of value
- method of deferred payment
what is a medium of exchange ?
without money transactions were conducted through bartering. (Goods and services were traded with other goods and services).
But people did not always get what they wanted or needed, and the goods and services traded were not always of the same value.
money allows for a double coincidence of wants (both parties want what the other party has to offer).
what is a store of value ?
money has to hold its value to be used for payment. can be kept for a long time without expiring.
what is a measure of value ?
money provides a means to measure the value of different goods/services.
what is a method of deferred payment ?
money can allow for debts and credit to be created.
what is the money supply ?
the stock of currency and liquid assets in an economy. (includes cash and money in saving accounts).
what is narrow money ?
a physical currency (notes coins), as well as deposits and liquid assets in the central bank.
what is broad money ?
includes the entire money supply.
includes liquid and less liquid assets.
what is the money market ?
where liquid assets are traded. used to borrow and lend money in short term.
what is the capital market ?
where equity and debt instruments are bought and sold.
(stocks and shares)
what is the role of financial markets in the economy ?
. to facilitate saving
. to lend to businesses and individuals
. to facilitate the exchange of goods/services
. to provide forward markets in currencies and commodities
. to provide a market for equities (trading shares on stock market)
what is equity ?
a stock or security which represents interest in owning an asset or firm.
why is there an inverse relationship between market interest rates and bond prices ?
There is an inverse relationship between market interest rates and bond prices.
When a bond is bought, money is lent to the issuer. The issuer agrees to pay the
value of the bond back when it matures, in addition to periodic interest payments.
The rate of interest is fixed when the bond is issued.
New bonds have rates close to the market interest rate. If the market interest rate
falls, for example, the bond would be worth more, since it carries a higher interest
rate than current market conditions. Similarly, the bond is worth less is the rate
increases. This is because the bond has a lower interest rate than the current
market.
why do firms sell corporate bonds ?
to raise funding for large projects, such as to expand the
firm, develop a product, move to a new premise, or takeover another firm. Bonds could be traded in a similar way to shares, and they are partially protected against
variable interest rates or economic changes. However, the firm will have to pay the
investors who buy the bonds interest.
used in quantitative easing
what is a bond ?
Money lent to the issuer. The issuer agrees to pay the
value of the bond back when it matures, in addition to periodic interest payments.
The rate of interest is fixed when the bond is issued.
what is the most liquid asset ?
cash
what is the least liquid asset ?
loans and long term bonds
why do banks needs to earn profits ?
to pay their debtors interest, wages and general expenses.
what is forward guidance ?
used by central banks to detail what the future monetary policy will be, with the intention to reduce uncertainty in markets.
e.g. MPC stating that they will keep the interest rate at a certain level until a specified date.
what are the factors considered by MPC when setting the bank interest rate ?
unemployment rate
savings rate
consumer spending
high commodity
(e.g. price of oil increases, leading to cost-push inflation as its a commodity the UK import, leading to the MPC increasing the bank rate to overcome inflationary pressure)
exchange rate
(e.g A weak pound would cause the average price level to increase. This makes UK exports relatively cheap, so UK exports increase. Since imports become relatively more expensive, there would be an increase
in net exports. The MPC might consider increasing the interest rate.).
how do interest rates influence exchange rates, in particular the strength of the pound ?
an increase in interest rates in the uk, makes the uk more attractive to invest funds into, because the rate of return on investment is likely to be higher.
this increases demand for the country, causing an appreciation in the pound for example.
this is also known as hot money flows.
why may the government regulate banks, with regulation and guidelines ?
to ensure the behaviour of banks is clear to institutions and individuals who conduct business with the bank, to ensure there is ethical behaviour.
what is the UK banking industry regulated by ?
PRA (Prudential Regulation Authority)
FCA (Financial Conduct Authority)
FPC (Financial Policy Committee)
what does the FCA do ?
aim to protect consumers interests by regulating financial firms to ensure they are being honest to consumers.
also aim to promote competition.
what does the PRA do ?
promotes the safety and stability of banks, building societies, investment firms, and credit unions, to ensure policyholders are protected.
what does the FPA do ?
regulates risk in banking and ensures the financial system is stable. it clamps down on loose credit in particular.
what is loose credit ?
its where credit is lended with very relaxed criteria, making credit easier to acquire.
what is a Moral Hazard ?
a situation where there is a risk that the borrower do things that the lender would not deem desirable, because it makes the borrower less likely to pay the loan.
usually occurs when there is some form of insurance for the mistake.
e.g. if a house is insured, a borrower might be less careful because they
know any damage caused will be paid for by someone else.
why can Moral Hazards occur with banks ?
may offer risky loans and take more risks because they know the Bank of England or the government can help them if things go wrong.
e.g. The financial crisis has been regarded as a moral hazard, due to the degree of risk taking.
what is a systematic risk in financial markets ?
the risk of damage to the economy or the financial market.
e.g. the risk of a bank collapsing, as this costs firms, consumers, the economy, and the market, creating a negative externality.
why are liquidity ratios used by banks ?
to determine how able a company is to pay off short-term obligations.
higher the ratio, greater the safety margins of the bank.
why are capital ratios used by banks ?
to assess the ability of the banks to take on more risks, and the financial strength., through assessing a banks level of credit borrowed.
what is the Central Banks relationship with the Government ?
it collects payments to the Government, and makes payments on behalf of the Government.
manages public debt and issues loans.
what is a government bond (not a bond issued by Banks) ?
a bond issued by governments to support Public Spending.
what is a limitation of quantitative easing ?
- depreciation of its currency
on FOREX markets due to reduced interest rates. leading to less investment and hot money flows into the economy.
Although this makes exports cheaper, imports become more
expensive, and because the UK imports a lot of raw materials from overseas, it could
trigger cost-push inflation .
how can fiscal policy be used to influence AS ?
. The government could reduce income and corporation tax to encourage spending
and investment.
. The government could subsidise training or spend more on education. This lowers
costs for firms, since they will have to train fewer workers. Spending more on healthcare helps improve the quality of the labour force, and contributes towards
higher productivity.
. Governments could spend more on infrastructure, such as improving roads and
schools.
what is Government Debt ?
the accumulation of the government budget deficit overtime.
what are direct taxes ?
taxes imposed on income.
what are indirect taxes ?
taxes imposed on the expenditure on goods/services, increasing the cost of production for firms.
. AD valorem (a percentage, e.g. VAT)
. specific taxes (set tax per unit)
what is a proportional tax system ?
fixed tax rate for everyone, regardless of incomes.
what are limitations of fiscal policy ?
- governments might have imperfect information about the economy, leading to inefficient spending.
- there is a significant time lag involved with employing fiscal policy, it could take years or months to have an effect
what is current government expenditure ?
spending which recurs.
e.g. spending on goods/services which are consumed and last for a short time. (spending on prescribed drugs for the health service)
what is capital government expenditure ?
spending on assets, which can be used multiple times.
e.g. expenditure on roads or building a school
what are transfer payments ?
welfare payments from the government.
they aim to provide a minimum standard of living for those on low incomes.
means to redistribute income from rich to the poor and reduce inequality.
e.g. Job seekers allowance (JSA), Child support
what happens if the governments debt gets too high, and confidence is lost in the governments ability to repay the debt ?
the government might have ti raise interest rates, to encourage investors to buy bonds, so they can finance the debt.
could lead to higher taxes, and periods of austerity.
what are two measure the government could take to improve equality and improve living standards ?
. progressive tax system and welfare payments
. government spending on housing, public services such as education and healthcare, providing equal opportunities for everyone regardless of their economic background.
what is a cyclical budget deficit ?
a temporary deficit, related to business cycle.
(e.g. deficit in a recession)
what are the consequences of a budget deficit for macroeconomic performance ?
- fiscal deficit could be inflationary
- could lead to crowding out, less investment and consumption
- increased interest rates
why can national debt lead to a rise in the cost of borrowing in a economy ?
The cost of borrowing could increase, since by borrowing money, the government is
increasing demand for credit in the economy.
what is the role of the Office for Budget Responsibility ?
.The OBR provides analysis of the UK’s finances.
.They produce 5-year forecasts for the economy, including the impact of tax and spending changes announced in the Budget.
.They judge the government’s performance against its fiscal targets. These are to
balance the budget 5 years ahead and have net public sector debt falling in 2015-16.
.They assess the likelihood of the government meeting the targets.
.They scrutinise tax and welfare spending measures.
.They also assess how sustainable public sector finances are in the long run.
what has increased Globalisation led too ?
interdependence between economies
what is Trade Liberalisation ?
The growing strength and influence of organisations such as the World Trade Organisation (WTO), which advocates free trade, has contributed to the decline in trade barriers.
what are the negative consequences of Globalisation in general for individual countries ?
. trade imbalance between countries (e.g. USA runs a large current account deficit with China)
. inequalities in consumers and countries access to health, education, and markets
. loss of cultural diversity, if there is a widespread of culture across the globe
what are the consequences of Globalisation to the Government ?
some governments might lose their sovereignty due to increase in international treaties.
(may have to abide by the rules of organisations that several countries are members of)
what are the consequences of Globalisation to producers and consumers ?
+ consumers and producers can earn benefits of specialisation and economies of scale as firms become larger.
+ firms operate in a more competitive environment, encouraging them to be more efficient reducing their AC
+ Globalisation leads to a general increase in world GDP, leading to increased living standards
what are the consequences of Globalisation to Workers ?
+ increased employment across the globe and their home country
- structural unemployment, due to firms developing more efficient production processes using automation and machinery.
what are the consequences of Globalisation on the environment ?
- pollution through increased production and car use
- depletion of natural resources (deforestation, water scarcity)
- increased consumer awareness about environmental sustainability
what is the money market ?
maturity date (payback date) of less than 1 year (< 1 year).
e.g. bonds, bank lending
what is the capital market ?
maturity date (payback date) of greater than 1 year (> 1 year).
e.g. bonds, shares
